Daniel Knowles writes for the Economist about politics and economics and is @dlknowles on Twitter.

Quantitative easing: not actually evil

Back in 2009, when the Bank of England first started its quantitative easing programme, Vince Cable denounced it as "Mugabe economics". George Osborne said it was "the last resort of desperate governments", adding that "in the end printing money risks losing control of inflation and all the economic problems that high inflation bring". Quantitative easing, it was implied, would devastate the country. All this free cash (printing money, everyone called it, as though you could still hear the presses rumbling on Threadneedle Street) would set off astonishing inflation; soon we'd be using £5 notes as cigarette papers.

Anyway, the fear continues today. At midday, the Bank of England is expected to announce it plans to buy another £75 billion worth of corporate bonds and government gilts with "new" money. The Spectator has published a story on its front page, with the headline "The Zero Era", and a nice cartoon of Mervyn King operating the printing presses. Meanwhile, in City AM, Allister Heath, an Austrian-leaning economist, writes that "capitalism can’t work properly with state-imposed negative real interest rates." Elsewhere, more trenchant (or less informed views) spread. John Higginson, the political editor of Metro, tweets his explanation for QE: "There is £100 and 100 loaves of bread costing £1 each. QE creates another £100. Each loaf now costs £2", for which he won the applause of the internet and a slot on Guido.

Behind all this is a simple logic – "printing" increases the size of the money supply, leading to more money chasing the same number of goods, and in turn, higher inflation. This fear – tangible in the United States, where Ron Paul leads a crazed assault on the Federal Reserve – is driving people to invest in anything solid they can get their hands on: gold, silver, oil, copper, grain and probably frankincense and myrrh too. Hyperinflation is coming – so says Glenn Beck anyway, presumably not at all influenced by the profits he makes from selling gold to his gullible listeners.

But the problem is, quantitative easing is not doing anything of the sort. QE hasn't increased the money supply – rather, it has prevented it from collapsing. As the Bank of England reports in its analysis of the effects of QE on the economy: "Broad money growth during 2009 and 2010 was the weakest for some 50 years." The Bank of England is not the only institution creating money out of nothing: ordinary banks do it every day, through the shocking voodoo process known as "fractional reserve banking". Yes, that's right: every day, your ordinary high street bank creates money "out of thin air".

Except that at the moment, the banks aren't creating money – they're destroying it. If you don't believe me, try getting a mortgage. Lending is down, to house buyers, businesses, students and everybody else. Banks are frantically cutting back their exposure and increasing their capital reserve ratios: the result is that there is less money in the economy. As The Economist noted last month, we're not in a lending boom – we're suffering another credit crunch. This month, the VAT increase will drop out of the inflation figures: don't expect inflation to stay above 2 per cent for long.

Sure, we probably ought to be concerned that the Bank of England now owns a third of the national debt (it certainly makes a mockery of some of George Osborne's statements) and The Spectator is right to raise that concern. But the general principle of printing money to prevent deflation is sound. The real problem is not that we are printing money: it is that the effects of low interest rates are not making it to the ordinary economy. The new money is jammed up in vaults, doing nothing. Bankers get low interest rates, as does the Government, and people who can get mortgages, but the people who want to spend mostly can't borrow, and so there is no overall increase in demand.

It's true – QE doesn't fix immediately fix this. But by speeding up the process of debt repayment, it might help us get out of this mess more quickly. And if not, well, perhaps the problem is what we do with our freshly printed sterling. Milton Friedman, the free-market economist who founded modern monetarism, argued that there may be a case for a "helicopter drop" of money – essentially a tax rebate for everyone, funded by printed cash. I've yet to hear a convincing argument against it.

Update – 12.05pm: Just to keep this in date, I'd better add that the Bank of England has just announced another £50 billion of QE.